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This page was processed by aws-apollo2 in 0. Skip to main content. Copy URL. See all articles by Michael P. Dooley Michael P. Number of pages: 32 Posted: 15 Feb You are currently viewing this paper. Number of pages: 35 Posted: 31 May Abstract A new aggregation scheme used to measure the sources of fiscal financing of indebted countries suggests that there was a fundamental improvement in the seniority of domestic debt at the expense of foreign bank debt during the late s. Dooley, Michael P. Michael P. Register to save articles to your library Register. Paper statistics.

Feedback to SSRN. The results in Figure 3 illustrate how the framework can help determine a scaling-up magnitude given a projected windfall path. When investment projects are less productive or the costs of absorptive capacity constraints are higher, fiscal adjustments would be larger and thus more difficult to implement. To avoid repeating the history that much of the public capital built under a windfall cannot have long-lasting growth effects, initial planning of an investment scaling-up must account for the future financing needs to sustain capital.

The above discussion of financing costs of public investment sheds some light on a fundamental question related to the Lucas paradox Lucas, and Gourinchas and Jeanne, forthcoming : Why is that in a capital-scarce economy, a public investment scaling-up cannot occur in the absence of a resource windfall? In our setup, part of the answer is the closed capital account reflecting tight borrowing constraints: Foreign capital does not flow easily to finance development.

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The country in our model, however, is implicitly able to develop the natural resource sector through FDI. In practice, and despite borrowing constraints, this is feasible since there are substantial rents from resource extraction that foreigners can appropriate. These rents then make the extractive industry foreign investment attractive even in the face of the usual barriers to international capital flows related to sovereign immunity and poor governance in recipient countries.

One may still wonder why a properly motivated government would not finance high-yielding public investments through its own revenue effort.


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A variety of distortions—some playing a role in the model presented here and many not—can explain why this typically has not happened. We emphasize two. One is again the financing constraint and closed capital account, which implies that to finance the scaling-up, countries would need to go through drastic fiscal adjustments and, therefore, possible substantial reductions in private consumption and investment. Second is the weak and distortionary domestic tax system captured here by low effective tax rates and the ineffectiveness of the income tax. CEMAC Application: Investing Without a Resource WindfallSolid and dotted-dashed lines assume a front-loaded and a gradual scaling-up path without a windfall, respectively; dashed lines assume a front-loaded scaling-up with a windfall.

Y-axis is in percent deviation from the path without a windfall unless stated otherwise. As expected, when scaling up without a windfall, the consumption tax rate has to adjust substantially. In particular, when public investment is front-loaded solid lines , the consumption tax rate has to jump drastically from 0. In the gradual scaling-up case dotted-dashed lines , private consumption does not fall as much, but the consumption increase in the new steady state is still minimal.

Without a windfall, welfare is higher if the scaling-up is not undertaken. In contrast, with the windfall, welfare is generally higher under either scaling-up approach all-investing or sustainable investing than with full saving of the windfall saving in an SWF. The CEMAC application shows that the sustainable investing approach can address the exhaustibility issue when investing under a short revenue horizon.

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This section demonstrates how this approach can also manage volatility in the context of the Angola application. Revenue volatility is introduced by fluctuating oil prices mimicking historical dynamics. With a long revenue horizon and high fiscal dependence on resource revenue, the resource fund analyzed for Angola is a stabilization fund, providing a fiscal buffer to smooth government spending.

The policy rule for savings in a resource fund is revised to allow for depositing and withdrawing, as shown in Equation Conversely, when there is a revenue shortfall, the fund is drawn down to maintain a level of investment commensurate with the given investment path. In the case of insufficient buffer, investment spending is cut to maintain a nonnegative balance in the fund.

Average standard deviation in percent from a de-trended path based on simulations. The spend-as-you-go approach is similar to the all-investing approach analyzed earlier.

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Instead of assuming that all resource revenues above the initial level go to investment, it is assumed that 60 percent of additional revenues goes to investment and the rest 40 percent goes to government consumption. With sustainable investing, we specify public investment to gradually increase from 8. Given a high government consumption to GDP ratio in of Both the labor and consumption tax rates are set at their initial steady-state levels, while transfers experience small fluctuations to clear the government budget constraint.

Table 3 compares the average standard deviations of public investment expenditure, private consumption, non-oil GDP, and the real exchange rate from to in percent deviations from their trend paths. All four variables exhibit more volatility—about 60—70 percent more—with spend-as-you-go.

Despite a rather smooth investment path, public investment under the sustainable investing approach can still experience some fluctuations. When large negative revenue shocks hit, the stabilization fund may not have sufficient balance to support a predetermined investment level, forcing investment expenditures to dip, resulting in the adjustments in macroeconomic variables.

In an economy that is highly resource dependent, the fiscal channel through which resource revenue volatility can affect macroeconomic stability is made explicit here. Conversely, when oil revenue declines, a procyclical fiscal policy as captured by spend-as-you-go can lead to a collapse of overall demand, generating a boom-bust cycle commonly observed in resource-rich economies.

When following the sustainable investing approach, one question remains to answer: How large should a stabilization fund be in an environment of uncertain future revenue? A more aggressive scaling-up leads to faster build-up of public capital and potentially higher economic growth. As more resource revenue is devoted to investment, less can be saved, leaving the economy vulnerable to negative shocks.

To address this policy question, we show how stochastic simulations can be used to advise the allocation between investment and saving in a stabilization fund. Angola Application: Conservative vs. Aggressive Scaling-Up under Sustainable InvestingY-axis is in percent deviation from the path without a windfall unless stated otherwise. The middle solid lines are mean responses based on simulations.

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The bands in solid lines are one-standard-deviation intervals, and the bands in dotted lines are two-standard-deviation intervals. Also, the very different performance of the stabilization fund confirms our conjecture that a more aggressive scaling-up plan leaves the economy with a small to little buffer.

By the end of , the stabilization fund is on average only 1. Since the stabilization fund is insufficient most of the time, the mean scaling-up magnitude from to at 15 percent also deviates much from the predetermined 20 percent. In contrast, the conservative path with a much larger buffer allows the realized investment path to follow closely the predetermined path.

Without much disruption in the investment pace, the depreciation rate of public capital is also kept low in most cases. The average depreciation rate of the 95 percent upper bound is 0. The aggressive path on average accumulates more public capital 40 percent vs. The one- two- standard-deviation lower band is 7. When oil revenues are hit by a sequence of large negative oil shocks, the aggressive path, which does not have much buffer, cannot sustain investment even at the level to maintain existing capital, and hence public capital can fall below the initial steady-state level.

Similar to the outcome with spend-as-you-go, large swings in public investment and hence public capital lead to great instability in the economy. As shown in Figure 5 , the confidence intervals are wider for non-oil GDP under the aggressive path. The one-standard-deviation interval ranges from 5.

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Moreover, despite a more stable economy with the conservative scaling-up path, households on average enjoy a similar magnitude of consumption as under the aggressive path. The endogenous depreciation channel plays an important role in linking revenue shocks to macroeconomic volatility. Bad revenue outcomes imply investment well below replacement rates, resulting in an increase in depreciation rates, thus amplifying the effect of the negative shock on the capital stock and hence output. This can be seen in the very high upper band for the depreciation rate in the case of aggressive scaling-up in Figure 5 , which is one of the reasons for the substantially worse lower band for public capital, GDP, and so on.

The comparison of the two specific investment paths suggests that scaling up too much and too fast as the aggressive path could subject the economy to more instability, lowers investment efficiency, and there is no guarantee that its growth impact can outperform a more conservative scaling-up path. Our analysis can be extended to alternative investment paths under different parameter calibrations for a more thorough assessment in the adequacy of a stabilization fund. Natural resource revenues provide an opportunity to accelerate economic development in capital-scarce economies that face financial and fiscal constraints.

These revenues, however, pose significant challenges to policymakers as they are exhaustible and volatile. The approach makes possible to achieve development goals by scaling up public investment while maintaining economic stability. The conversion of the windfall into permanently higher income is the key policy concern. In Angola, a highly resource-dependent economy with large reserves, managing price volatility is the priority. The sustainable investing approach explicitly accounts for the financing needs involved in operating and preserving capital.

The current literature on managing natural resources often neglects the fact that even if a government manages to build productive public capital by implementing good projects implying high efficiency and absorptive capacity , its return will diminish over time unless revenues are available to cover recurrent costs. The failure to preserve public capital and cover recurrent costs has been an important theme in development public economics at least since Heller and remains of great practical significance.

With limited revenue mobilization, our analysis implies that the size of the scaling-up plan should be jointly considered with an economy's ability to finance future costs to sustain capital and to the distorting effects of fiscal adjustments.

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In cases where exhaustion lies beyond the horizon but resource revenue volatility looms large, sustainable investing avoids procyclical fiscal policy and minimizes the disruption in macroeconomic stability. Scaling up public investment too high and too fast—for example, following the path of resource revenues themselves—also lowers investment efficiency and risks higher depreciation rates. There is no guarantee that growth outcomes will be superior to a more conservative scaling-up path.

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In addition, it makes the economy more prone to boom-bust cycles. Sustainable investing, on the other hand, de-links periodic government spending from resource revenue flows, through a stabilization fund and thus shields the domestic economy from the disturbance of volatile resource revenues.

A number of extensions could usefully be considered. We focus on public investment in physical capital; the analysis can be extended to other types of investment, such as health and education to build human capital, which also improve the productivity of private inputs in production.


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  5. We study some simple and implementable government rules; a fuller consideration of rule-based optimal policy, while not trivial in such a complex model, would clearly be useful. In addition, the model could readily be adapted to address short-run policy issues by introducing, for instance, nominal rigidities. Finally, natural resource booms can relax borrowing constraints, which may induce debt stability problems.